Investors see gold rush in renting foreclosed homes

By: Reuters March 21, 2012Comments Off on Investors see gold rush in renting foreclosed homes

Dan Magder recently gave up a top job with private equity firm Lone Star Funds to strike out on his own and become a landlord.

He’s joining a growing list of big and small investors who see fat profits to be made in renting out foreclosed homes, especially now the U.S. government is moving ahead with a trial project to sell big pools of single-family homes that Fannie Mae currently owns in some of the hardest-hit housing markets.

Investors seeking higher yields are drawn to foreclosures because the rental market is red hot. But the heated competition for foreclosed homes is reminiscent of the frothy expectations that seem to accompany each new Wall Street investing craze.

[dmc-related-post-wp numitems=”3″ title=”Also read”]

Even proponents of buying foreclosed homes are advising caution about the kind of returns that investors can expect to reap and the potential negative headlines that can come with being a landlord.

Critics, meanwhile, contend the federal government is fostering a transfer of wealth of sorts by selling big pools of foreclosed homes to big fund investors and high-net-worth individuals. There’s also concern that some of the players who helped create the housing crisis will now benefit by buying foreclosed homes at a steep discount.

Between them, Fannie and Freddie Mac own more than 200,000 foreclosed homes. The nation’s banks own more than 600,000 single-family homes, according to RealtyTrac, a housing tracking service.

Housing experts expect the foreclosure machinery to crank up again now that regulators and banks have agreed to a $25 billion settlement to deal with earlier foreclosure abuses.

The Federal Housing Finance Agency, which regulates Fannie and Freddie Mac, expects it will receive a considerable number of bids in April for the initial round of 2,500 Fannie-owned homes in cities like Atlanta, Chicago, Los Angeles and Phoenix.

“This is really a test and we don’t know what the results will be,” says Meg Burns, senior associate director for housing and regulatory policy for the FHFA. “But the beauty of this pilot is we are going out with properties that are largely rented already, so people know what the cash flows look like and we know it is far preferable to have people living in the homes rather than the properties sitting vacant.”

In August, when the FHFA first announced its intention to conduct bulk sales for Fannie and Freddie properties, it received expressions of interest from more than 4,000 investor groups, not-for-profits and other organizations.

If the pilot is successful, the FHFA is also considering selling off pools of distressed mortgages held by Fannie and Freddie, according to people familiar with discussions about that.

On the Internet, the gold rush mentality clearly has taken hold with some small investment firms. Wong Diversified International Investments of Austin, Texas, for example, offers a fund to invest in foreclosed homes, boasting on its website that it is pursuing the Fannie bulk sale.

“It is clearly over-hyped, but I think this is real and it’s going to happen,” said Magder, who about a week ago left Lone Star, where he had focused on distressed banks and financial services firms. “There is definitely room for people who have a well-thought-out operational plan and are careful about putting the pieces together.”

Magder has formed Rock Creek Capital Group, based in Washington, D.C., and intends to raise money from investors and submit a bid for some of the foreclosed homes Fannie is selling in Los Angeles and Phoenix and across Florida.

RETURN ON INVESTMENT

One of the most bullish investors is Carrington Capital Management, which has teamed up with Los Angeles-based OakTree Capital. They have created a $450 million fund to buy foreclosed homes in bulk and rent them out.

In a marketing document for one of its funds, Carrington claims that without using leverage or borrowed money it can generate an annual yield of 7 percent from rental income alone. Its long-term strategy is to package the fund into a publicly traded real estate investment trust. If that strategy is successful, Carrington projects investors can see an internal rate of return of 25 percent over three years.

Rick Sharga, an executive vice president with Carrington, says the firm is optimistic that if the Fannie auction attracts a lot of bidders, then banks will begin holding their own bulk sales of foreclosed homes.